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direct taxation of business income/profits jurisdiction to tax and double taxation tax treaties

Law School. International Business Structures & Regulation Sol Picciotto Topic 5: International Taxation and the`Offshore’ Problem. direct taxation of business income/profits jurisdiction to tax and double taxation tax treaties international tax avoidance and evasion

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direct taxation of business income/profits jurisdiction to tax and double taxation tax treaties

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  1. Law School International Business Structures & RegulationSol Picciotto Topic 5: International Taxation and the`Offshore’ Problem direct taxation of business income/profits jurisdiction to tax and double taxation tax treaties international tax avoidance and evasion tax havens and offshore centres anti-avoidance and anti-haven measures pricing of intra-firm transfers advanced pricing agreements and unitary taxation IBSR Topic 5

  2. Direct Taxes: employment income investment income: passive/portfolio active/direct Indirect Taxes: sales (VAT) transactional: stamp duty, air tickets, insurance Capital: gains, property, death duties Payroll & Social Security Source or Residence deduction withholding Destination or Origin Place of transaction Physical location Place of employment Taxes & Jurisdiction IBSR Topic 5

  3. Home State Residence/nationality where recipient located Capital-export equity Host State Source: where income earned Capital-import equity Jurisdiction to Tax Investment Income Home stateResidence Host stateSource investor Withholding investor Deduction at source business IBSR Topic 5

  4. Taxing Residents on all income (residents in the territory) capital-export equity equal tax on investments at home/abroad Taxing Income from All Sources (income earned in the territory) capital-import equity same taxes on all local business whoever the investor Overlapping Jurisdiction & International Double Taxation A B Firm X(investor) investors dividend/interest/fees Affiliate X-1 Juridical Double Taxation same person’s income taxedtwice if earned abroad Economic Double Taxation same income stream (intra-firm payments) taxed twice IBSR Topic 5

  5. Investor X in A taxed @ 40% B taxes all income @ 30% X-1 declares £100 profit as dividend to investor A B applies 30% to all dividends at source (withholding tax) A unilaterally US since 1917 taxes worldwide income subject to Credit A & B by Agreement to encourage international investment 1. Foreign income exemption dividend of £70 untaxed in A incentive to invest in lower-tax state 2. Foreign tax paid = expense £70 taxed @ 40% = £28 X’s net income £70-28=£42 (on domestic investment = £60) 3. Foreign tax credit X’s total income £100 charged £40 A credits £30 tax paid in S X’s net income £60 X pays higher of Home/Host tax rate (same rate as domestic investment in A, higher than investor in B) Preventing Double Taxation of International Investment Income IBSR Topic 5

  6. Tax Treaties League of Nations conference 1928: Model treaties Direct Taxes Succession Duties Administrative Assistance in Assessment Assistance in Collection of Taxes Mexico drafts 1943, London 1946 UN: Commission > Group of Experts OECD Fiscal Affairs Committee Model Treaties + Commentaries + Reports Network of Bilateral Tax Treaties > c.2, 200 IBSR Topic 5

  7. Residence state place of incorporation/ centre of vital interests Business Profits - art.7 subsidiary taxable by Host state Associated Enterprises - art.9 profits = Arm’s Length Foreign Investment Income remittances from subsidiaries dividends interest on loans fees and royalties Source State income from immovable property income attributable to a Permanent Establishment (PE) attributable = sales/other activities effected through PE PE = fixed place of business, e.g. branch, factory, office mine, oil/gas well ?building site / oil rig if > 6/12 months Tax Treaties’ Allocation of Tax Jurisdiction IBSR Topic 5

  8. International Tax Avoidance evasion = deliberate concealment/deception, illegal - tax fraud avoidance = choosing form of transaction to minimize tax liability tax planning - game, industry using ambiguity / indeterminacy of law - loopholes may be disallowed, tax liability imposed problems: intention, concealment - when is information relevant role of tax adviser: Dimsey Reformulating Transactions, to change recipient: intermediary (Frost: income received by partnership) nature of payment (Frost: for right to services, not fee to performer) Oil producing states switch from per-barrel royalty to profits tax 1949 timing of payment: deferral of liability IBSR Topic 5

  9. Avoiding Residence Taxes UK USA deferral of Home taxes on unremitted income income source e.g. Fee A- Resident asset new recipient - income retained (abroad) payment recharacterised Bahamas A-owned entity IBSR Topic 5

  10. Avoiding Source Taxes UK USA intra-affiliate payments deductible as costs by operating company, paid to Conduit in treaty-haven income source e.g. Fee $100 A- Resident Treaty - no US withholding tax Bahamas C-treaty $99 asset Conduit stepping-stones IBSR Topic 5

  11. Tax Havens Base-Haven no/low (income/profits) tax: e.g. Cayman Is, OR exemption for non-residents, e.g. “International Business Company” Treaty-Haven tax treaty limiting Source state withholding Secrecy Bank records: no disclosure to (foreign) fisc fiduciary accounts - beneficial owner concealed company ownership - bearer shares, owners not registered company accounts: limited filings, not enforced professional-client confidentiality Respectable vs Disreputable Centres? IBSR Topic 5

  12. Globalization & Tax Competition Emergence of tax havens 1920s family wealth & business, e.g. Vesteys Postwar direct capital flows & finance exploitation of tax deferral on retained earnings by TNCs current account convertibility 1958- `offshore’ banking & international capital markets deposits in havens $11b 1968, $368b 1978 Liberalization of investment flows & capital flight complete convertibility 1979- 1984 US & UK end WT on interest to non-resident portfolio investors 1988 German WT on interest abandoned Competition for investment 103 states offer investment incentives by 1988 IBSR Topic 5

  13. Anti-Haven Measures Anti-Base Measures Controlled Foreign Corporation - CFC `passive’ income deemed that of owners in Residence state CFC must be in `low-tax’ jurisdiction: what is `low’? definition of `owners’? definition of `passive’ income - no `real’ activity Anti-Conduit denial of treaty benefits if recipient not beneficial owner need for cooperation from Conduit state denial of WT exemption to payments interest - if subsidiary thinly capitalised Information Exchange partner should obtain information even if not needed by other state for its own tax collection purposes IBSR Topic 5

  14. Havens & `Harmful’ Tax Competition OECD Fiscal Committee 1998 Report EC `Code of Conduct’ + `peer review’ + state aids Tax Havens / Preferential Tax Regimes Criteria: No/nominal taxation (low effective tax rate) tax holidays; exemption of foreign source income? Lack of transparency secret rulings, negotiated tax privileges Lack of (effective) exchange of information only information already obtained for its own enforcement? No Substantial Activities / Ring-Fencing now dropped? Action: listing uncooperative havens Tax Haven Update commitments: no new HTPs; `effective’ information exchange coordinated defensive measures? Parity of treatment of non-OECD? Switzerland information exchange, bank secrecy Exchange of Information: Topic IBSR Topic 5

  15. Transfer Pricing Pricing of inter-Affiliate Transfers goods (40% of trade), interest on loans (thin capitalisation), IPR royalties, services (joint/fixed overheads) Profit-Centre management - tax accounts may differ TP manipulation = reduce profits in high-tax country League of Nations 1935 Report > Arm’s Length Rule art.7.2: PE business profits “which it might be expected to make if it were a distinct and separate enterprise... and dealing wholly independently with the enterprise of which it is a PE” art.9 Associated Enterprises: if relations “differ from those which would be made between independent enterprises, then any profits” may be reallocated Adjustment of Accounts of related enterprises transaction prices, or profit (re)allocation? IBSR Topic 5

  16. Transfer Price Adjustments US Tax Code s.482 (since 1928) allows reallocation 1968 Regulations: Transaction-Based Comparable Uncontrolled Price - CUP: exact comparables? Resale Price Minus (margin): if reseller doesn’t add value Cost Price Plus (margin): data problems “Other” methods? Profit-split as check 1986 amendment: profit must be “commensurate with income attributable” to an intangible (IPRs) Profit-Based Profit Split: splits actual (group) profits CPM: applies `comparable’ profit margins to split profits from transactions (each contribution based on functional analysis) Hybrid? TNMM: net profit margin based on comparables Problem: allocating joint costs, profits from synergy Administered Pricing, negotiated with Revenue IBSR Topic 5

  17. Cooperation Between Tax Authorities Corresponding Adjustments: State B adjusts Transfer Prices/Profits after State A has taxed Affiliate on those profits, `other state [B] shall make an appropriate adjustment to the amount of tax charged’ (art.9.2) Obligation to Adjust? `the competent authorities shall if necessary contact each other’ Competent Authority Mutual Agreement procedure - art 25 Taxpayer claim of taxation `not in accordance with’ treaty Binding arbitration: as final resort: US-Germany EU Convention, for TP (little used, no ECJ jurisdiction) Information Exchange art. 26 `shall exchange necessary info.’ if obtainable under domestic law on request, automatic, spontaneous only if already obtained from taxpayer? IBSR Topic 5

  18. Coordination of Assessment Simultaneous Examination of Related Entities Bilateral agreements: Residence & Source states combine to check `leakage’ via intermediaries in Havens Advanced Pricing Agreements Transfer Pricing methods approved in advance (bilaterally) Provide certainty, but expensive and open TNC to scrutiny Formula Apportionment & Unitary Taxation? Developed especially in US (California) extended worldwide `unitary’ enterprise must submit Combined Accounts Apportionment Formula: payroll, property, sales May result in Double Taxation unless there is agreement on (i)definition of tax base; (ii) apportionment formula Suitable for EU? IBSR Topic 5

  19. Global Taxation of TNCs? Tax Differences Distort Trade/Investment Tax incentives to encourage Exports WTO: Subsidies Code: FSC Case (Panel 2001, AB 2002) Tax incentives to attract FDI `discipline’ in Investment Agreement? Tax Competition `Harmful’ or Desirable? OECD Forum & its Extension New International Body? IBSR Topic 5

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